In light of the ongoing coronavirus pandemic, most people are refocusing their energies on physical and mental health, relationships with family and loved ones, and improving our skill sets and self-improvement. Let’s deep dive into consolidating stock in this article.
During the COVID-19 lockdown, some people are also day trading stocks to make some additional cash.
Even though consolidation occurs so frequently in the stock market, you should learn more about it if you’re thinking about day trading stocks through the lockdown.
The purpose of this article is to explain the meaning of stock consolidation, how to recognize it on charts, and then how to apply it to trades.
The information in this article will hopefully help you make the right decisions when the market conditions change from easily tradable to less favorable.
What is Stock Consolidation?
Security (stock) that is consolidating is neither continuing nor reversing a larger trend. Until another pattern emerges, consolidated stocks provide relatively few trading opportunities. Traders and analysts consider consolidation periods to be indecisive and cautious.
As the market digests the news that resulted in the price movement, consolidation occurs after sharp price movements. Consolidation is generally interpreted by traders as indecision on the part of the market.
In addition to helping businesspeople place themselves for the ensuing move, consolidation periods are also required for collection and disposal. Furthermore, they are used by ‘big’ players to gain greater market share.
How to Recognize Consolidation on a Chart
Identifying a stock that is consolidating can be done by watching for three properties appearing simultaneously on its price chart.
As a flag continuation pattern, the stock has definable and steady support and resistance levels.
A narrow trading range is the second characteristic. There are some stocks and securities that are more volatile than others, however. Volatility is relative.
One more feature to look for is a relatively low level of trading volume that does not exhibit major spikes.
By itself, consolidation has neither positive nor negative effects. It often occurs after a healthy price movement. To smooth out moves before another trend emerges, traders may look to smooth out overbought or oversold positions.
Why does Consolidation Differ?
The consolidation of stocks is different from the performance of other stocks. It is more common for stocks to go up or down in price.
Volatile stocks make significant moves over a while. A stock that opens at $10, rises to $12, drops to $7, and closes at $10 is considered highly volatile. Major events tend to cause this volatility.
Secondly, trending is popular price action. This is when the stock continuously makes higher highs and higher lows and vice versa. In a certain period, a stock that goes from $10 to $15 is said to be trending. Stocks that are volatile and trending are profitable for traders.
Ways to Trade Consolidation Strategies
Traders who have been in stocks trading know that the stock markets constantly move sideways. Consolidation plays a huge role in the market’s balance. So, it is important to understand the procedures that use the consolidating types of market environment.
Because of the limited price action that occurs during consolidation, it is among the worst times to trade a stock. We also noted that post-M&A consolidation is the worst because the shares will not move much.
Traders can trade other types of consolidations by looking for bullish or bearish breakouts. Breakouts occur when price moves out of consolidation and begins a new trend.
Consolidations are relatively easy to trade since they are part of price action charts. For example, when a bullish trend ends, a consolidation occurs. Upon closer examination, we see that it is a bullish flag or a bullish pennant. Flags and pennants are usually signs that prices will break out higher, as we have written before.
In contrast, a breakdown is a breakout that moves downside. Despite trading sideways a bit, the stock can’t be strong enough to move up.
A consolidation usually occurs when there is an inner flaw in the assets, and the move downward usually follows. Later, the stock price breaks down and finally exchanges above the consolidation low.
The situation is similar to that of a bodybuilder who always attempts to lift the weights but cannot do so. The weightlifter crashes the weight to the floor when the pain is too much. Just as losing weight is easier than maintaining it, a stock sinks four times easier than it rises.
There are two ways to trade this pattern. As long as the price breaks out, you can place a buy stop at the highest point. As a second option, you can use the break and retest consolidation technique. A bullish breakout is to be waited for and then retested. Here is a chart of CRM’s bullish flag pattern.
Support and Resistance in Consolidation
Both levels in a consolidation pattern are determined by the lower and upper bounds of an asset’s price. Support is the lower end of a price pattern, while resistance is the top.
Whenever the price breaks through areas of support or resistance, volatility increases and short-term traders have a greater chance of making money. Traders who use technical analysis believe a breakout above resistance means the price will climb further, so they buy. If the price breaks below the support level, the trader will sell, and the price will fall even lower.
Often, a support level becomes a resistance level after a bearish breakout and a resistance level becomes a support level after a bullish breakout. In some cases, consolidations exhibit triangle or pennant patterns, making it possible to use continuation strategies.
Find out how long the pattern has held before you begin trading it. Consolidation doesn’t have a significant time limit. Consolidations can be done in short bursts during the day. A technical analysis software program will provide you with dynamic information updates if you are looking for active intraday trading.
Consolidations can last for weeks, months, even years. Patterns such as these are prone to false breakouts, so it is crucial to seek confirmation of prices before jumping into a trend.
Contrarians and counter traders can still profit from narrowly consolidated stocks, but they often have less room for profit since the range is narrow.